3 Consequences From a Potential Delay at Solazyme

April is nearly in the books, and renewable oils company Solazyme (NASDAQ: SZYM) has yet to announce that its manufacturing facility built with feedstock supplier Bunge (NYSE: BG) in Moema, Brazil, has initiated operations. The announcement heralding start-up was expected this month after the commissioning of downstream oil separation equipment, but investors are still awaiting an official update. While it's possible everything is on schedule for the facility that will sport an annual nameplate capacity of 100,000 metric tons, there are a few very logical reasons investors would want to prepare for a delay.

Source: Company Presentation

First, Solazyme just completed a massive offering of debt notes and common stock that will give it roughly $300 million at the end of the second quarter. That could be used for any number of reasons, including an expansion of manufacturing capacity, but it may have been raised as a cushion for manufacturing problems at Moema. Second, the company has never operated a commercial scale facility, and certainly not one as large and complex as what is planned in Brazil. The process scheduling for such a massive facility -- using 625,000-liter tanks for the first time -- presents many potential sources for problems. Third, biology is difficult to scale. Some misinterpreted my earlier effort to characterize the problems encountered in the industry to date, but industrialization isn't about scale (volumes of the tanks); it's about reproducibility.

Couple the quick thought experiment above with the interesting schedule of events in the next week (Solazyme announces first quarter earnings on May 5, while Bunge holds its first quarter conference call on May 1), and investors may want to consider what it would mean if the companies have experienced a delay. Here are three potential consequences.

1. Expansion of manufacturing capacity and product partnerships could be halted.Does Solazyme have enough cash on its balance sheet to push through potential problems at Moema? It's very likely. Is it reasonable to assume the company has enough cash to push through potential problems and court partners for manufacturing capacity expansion? Again, that is also very likely. Those aren't the only concerns investors should have, however. Not all potential delays at Moema would have to be technical in nature, but technical delays could result in a bigger headache for Solazyme and investors than, say, personnel or permitting issues.

Depending on severity, potential expansion partners could decide to wait things out before committing to a manufacturing joint venture or facility. The same could be true for companies eyeing Solazyme's renewable oil products. There would be little incentive to ink a supply deal with Solazyme and Bunge if there was uncertainty surrounding the ability to reliably produce goods. Then again, if problems are dealt with quickly, or relatively quickly (sometime in 2014), then Solazyme's strong cash position would certainly help it recover any lost ground.

2. Solazyme Renewable Oils may go unconsolidated in 2014.Moema will have an annual nameplate capacity of 100,000 metric tons, although ramp-up will take 12-18 months. Investors are well aware of that. However, investors are still in the dark about what needs to occur for Solazyme to consolidate the joint venture with Bunge and reflect sales from the facility on its own income statement. Rather than occur at start-up, consolidation is tied to production milestones achieved during ramp-up. We cannot yet answer questions such as "what are the conditions?" and "when will the conditions be achieved?", but a start-up delay could jeopardize the ability to meet those milestones in 2014.

Source: Solazyme.

With production volume heavily weighted toward the end of ramp-up, it seems reasonable to ponder the ability to meet consolidation milestones in the event of a delay.

3. Wall Street revenue estimates invalid (again).I am 1,000% sure that the average Wall Street estimate for 2015 revenue for Solazyme will be lowered -- even if Moema begins production in the next several days or weeks. However, things get interesting for 2014 estimates if Solazyme and Bunge encounter a delay. I believe the margin for error to meet the current revenue estimates of $117 million for this year would be incredibly small if Moema begins operations in the beginning of May. A delay would almost certainly make that figure unattainable due to lost product sales (compared to previous start-up dates), the potential for unconsolidated results from the Solazyme Renewable Oils JV, and wary customers.

Source: Solazyme.

Additionally, delays at Moema have the potential to delay cash-flow positive and profitable operations for Solazyme by several quarters or more. Similar to production volume, the optimal margins will only begin to be achieved in the second half of ramp-up activities. How would Wall Street react to such risks to the company's income statement?

Foolish bottom linePlease don't misconstrue my analysis of the fallout from a potential delay at Moema as a bearish sentiment -- I'm simply helping investors objectively consider the consequences of a delay. As you can see, it may not be as simple as pushing through problems with a strong cash position. Nearly $300 million in cash at the end of June will help, but manufacturing partners and customers don't care about Solazyme's balance sheet, they care about how reliably it can produce goods. So, what news will break about Moema? We don't know yet, but we will soon. Sit tight.

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Why don't you just save everyone the time of reading the article and say "if there's a delay, er...ah... there will be a delay". I mean come on get real. You don't know if there's a delay, the nature of the delay, how long the delay will be, how serious the delay problem is and, obviously, if there's a delay it will delay---everything-- because it's a start up venture at Moema.

I don't care if you're Tesla or Google glass or Obama Care, delays happen. And it means one thing--delay. Without knowing more, we might as well go get henny penny and and foxy loxy and run around chanting about the sky.

For we investors, delay means less for current investors and more for later investors. There are investors who have been waiting 3 years now. There are investors who just found this stock yesterday. Timing in investing is just about everything, right?

As far as your comment about biology not working at scale, how do you explain their Clinton facility and Encapso?

Everyone will rationalize a potential delay in their own way (despite the bullish talk leading up to it), but for a company that has continuously hit milestones, a delay at Moema could be more severe than many care to think and effect more aspects of Solazyme the business. I wanted to provide the thought experiment.

"As far as your comment about biology not working at scale, how do you explain their Clinton facility and Encapso?"

Sigh. It's not a comment, it's reality. The point is that industrialization is about reproducibility, not scale. Last I checked Clinton wasn't at nameplate (shipped 30 truckloads at last count, which is 30 x 5,000 gallons) and Encapso is a product line, which has nothing to do with the fact that biology is difficult to scale. There are thousands of products out their that have been developed through industrial biotech. How many are being consistently produced at scale?

Encapso is a product line, which has nothing to do with the fact that biology is difficult to scale.

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Encapso is just a product line? Doesn't the fact that you just acknowledged it's in the marketplace and being produced at Clinton with at least 30 truckloads back in March cut against your statement? Didn't you just implicitly acknowledge that Encapso has been made at scale and is currently under commercial production and being sold? So you bring out the fact that Clinton is not at nameplate capacity? Did anyone say it would be by now? If not then what's that go to do with refuting the fact that this biology is currently being produced at scale?

They just had the big dogs GS and MS and institutional investors in the house and raised 200m cash. Doesn't seem like the big dogs would be so interested if there were the problems you imply. Seems like if SZYM took these guys' 200m and then only after the fact told them the biology wouldn't work at scale that there'd be some pretty nasty lawsuits bearing down on them and they'd lose everything.

You're still not understanding the meaning of "biology is difficult to scale". Perhaps I should say "industrialize" instead of "scale" to explain it to investors, but those in the industry use the phrase quite often and I think my prior article explained it well. It has nothing to do with running a gajillion liter tank a few times or producing a product at the maximum scale a few times.

"They just had the big dogs GS and MS and institutional investors in the house and raised 200m cash."

Yes, there aren't many companies to choose from when registering an offering. Please look and tell me about the generous fees each bank got for its hardship of attracting buyers for the debt notes and booking the common stock offering with the exchange.

We'll see what happens when the company announces in the next week or so. Do I get an apology if I'm right?

We'll see what happens when the company announces in the next week or so. Do I get an apology if I'm right?

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You certainly get an "I told you so". And I'll pay where it hurts most--with my losses. But and apology from me? Worthless. No, it won't be me misrepresenting what SZYM has publicly stated it has and can do. Wolfson is the one who should be apologizing if you are right.

And you present what I dislike about the SZYM management team--and that is that Wallstreet doesn't trust them. Heck, I don't trust them after they did the secondary at $11 when the stock was trading at $13. If Wallstreet trusted them, with the disruptive technology they are allegedly bringing to market, this stock should be at $50 a share. This stock should be a Tesla.

You bring up an interesting point comparing it to Tesla. Is there massive growth potential? Yes. I think the market is still wary of next-generation industrial biotech given the lack of results to date, though. So it's a little more difficult to pencil that growth into models when that major uncertainty (industrialization) is looming. Will the platform work eventually? I really don't think that's even a question -- yes. Unfortunately, that's not how Wall Street works.

And while I think Wolfson is a tremendous leader (not many founders remain on the team this long or as CEO), he's clearly not an Elon Musk to Wall Street. That comes with connections, an impressive and successful track record with multiple ventures, and a certain desire to be on his team. Nothing against Wolfson, but the "Musk factor" helps fuel ridiculous valuations for SolarCity and Tesla.

There could be some interesting movement in the stock in a few years when capacity expansion will fuel EPS growth projections (similar to Tesla now), but the stock probably has no shot at much higher multiples this year or most of next.

As a biologist and investor, I fully understand your communication. It makes total sense. What Solazyme is producing comes from a combined bio-art and science process. One can quantify the time component of science. The art component is a different challenge. And the most rewarding. We shall find out shortly.

A senior engineer from Bristol-Myers Squibb once told me, "Scale up is more art than science."

That was true some time ago, but luckily, people cringe when they hear that now. We're now beginning to think about biology and engineering principles together, which will take the "art" out of the equation and make industrial biotech truly reproducible. That would make long ramp-up timelines a thing of the past, too. The future is pretty great.

There could be some interesting movement in the stock in a few years when capacity expansion will fuel EPS growth projections (similar to Tesla now), but the stock probably has no shot at much higher multiples this year or most of next.

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No way. The interesting movement will come when the masses understand--or should I say SZYM proves-- that SZYM can do what it claims it can do. (And you are the quint essential doubting Thomas that dominates in the public opinion at the moment.) Once that is proven--this stock is going to the moon. Why? Because it's just a cookie cutter process from there on out and it will be junior high math to extrapolate what's coming. Think 3-10 plants in every country producing tailored oil right next to where it needs to be used. Every industry on the planet is going to want a piece of patented micro-algae.